By: Patrick Boyaggi, CEO & Co-founder of RateGravity

Background

If you own properties in addition to the one you are purchasing or refinancing, there are some important implications for how your lender will qualify your loan. Specifically, lenders will look at the associated income and/or expenses of any other properties and include that in their calculation of your debt-to-income ratio (DTI)

What You Need to Know

Calculating Income/Expense from Other Properties

Eligible Properties: Rental income is an acceptable source of stable income if it can be established that the income is likely to continue. If the rental income is derived from the subject property (i.e. the property being purchased/refinanced), the property must be one of the following: 1: A two- to four-unit principal residence property in which the borrower occupies one of the units, or 2: A one- to four-unit investment property.

Documenting Rental Income: If a borrower has a history of renting the subject or another property, generally the rental income will be reported on IRS Form 1040, Schedule E of the borrower’s personal tax returns. If the borrower does not have a history of renting the subject property, the lender may be justified in using a fully executed current lease agreement.

Calculating Monthly Qualifying Rental Income (or loss):

Lenders typically use the Agency guidelines on Schedule E income, to calculate qualifying rental income. Under this methodology, the lender must add back any listed depreciation, interest, homeowners’ association dues, taxes, or insurance expenses to the borrower’s cash flow. If the property was in service for the entire tax year, the rental income must be averaged over 12 months. If the property was in service for less than the full year, the rental income must be averaged over the number of months that the borrower used the property as a rental unit.

In the event of a purchase transaction and a lease agreement is used, the lender must calculate the rental income by multiplying the gross rent(s) by 75%.

Treatment of the Income (or Loss):

The amount of monthly qualifying rental income (or loss) that is considered as part of the borrower’s total monthly income (or loss) — and its treatment in the calculation of the borrower’s total debt-to-income ratio — varies depending on whether the borrower occupies the rental property as his or her principal residence.

If the rental income relates to the borrower’s principal residence:

-The monthly qualifying rental income (as defined above) must be added to the borrower’s total monthly income. The income is net of the full amount of the mortgage payment (i.e. Principal, Interest, Taxes, Insurance and Association Dues (if applicable) of the property (PITIA).

If the rental income (or loss) relates to a property other than the borrower’s principal residence:

-If the monthly qualifying rental income (as defined above) minus the full PITIA is positive, it must be added to the borrower’s total monthly income.

-If the monthly qualifying rental income minus PITIA is negative, the monthly net rental loss must be added to the borrower’s total monthly obligation